Topic 1: What should you do with your debt mutual funds?
It looks like the woes of debt fund investors are far from over. In an unprecedented move, Franklin Templeton Mutual Fund has announced the winding up of six of its debt schemes as it faced severe redemption pressure and illiquidity in the bond markets due to the ongoing Covid-19 crisis. The schemes that Franklin Templeton Mutual Fund has closed are Low Duration Fund, Ultra Short Bond Fund, Short Term Income Plan, Credit Risk Fund, Dynamic Accrual Fund and Income Opportunities Fund. According to data available on the Value Research website, these schemes collectively hold assets of ₹30,853 crore, as of March-end.
With businesses grinding to a halt amid the lockdown, their ability to service debt obligations has become questionable. As a result, many debt fund investors rushed to redeem their investments—debt funds saw one of the highest-ever outflow of ₹1.94 trillion in March. For debt funds, this became difficult to handle as poor liquidity in the debt markets limited their ability to sell the securities. Though the Reserve Bank of India (RBI)took steps, including opening rupee-dollar swap windows and conducting long-term repo operations (LTRO), to improve liquidity in the bond markets, these were too little, too late for Franklin Templeton. So what does this mean for investors in these Franklin Templeton schemes and will it impact investors in other debt funds as well? We try to give the answers.
Investors in the affected schemes
If you have invested in any of the six affected schemes of Franklin Templeton, there’s literally no way out. No investments or redemptions are allowed in these schemes as of now. So you will not be able to redeem, switch out or transfer money from these schemes or start a systematic investment plan (SIP) or invest lump sums in these schemes.
Also, you will receive the proceeds the fund house is able to recover by liquidating the underlying investments in proportion to your holdings. From the investor’s perspective, the fund house will give back whatever money it realizes over a period of time.
How much money you’ll get back will depend on your investment amount as well as the amount the fund house is able to recover. It is uncertain when you will get the money as it will depend on how fast the fund house is able to recover it.
Investors in other debt schemes
The event will also impact schemes of Franklin Templeton Mutual Fund that invested in any of the six schemes, as they will not be able to exit these holdings. For instance, Franklin Templeton India Asset Allocation fund was holding around 46% of its assets in the Short-term Income Fund, as per the March-end portfolio. It will also severely impact the sentiments of investors in other debt schemes of Franklin Templeton, as well as those of other fund houses.
If you are invested in other debt schemes, don’t make this event a turning point for you. Instead, try to assess your fund by doing a portfolio review, asking the right questions and checking your exposure.
A portfolio that predominantly holds securities that are rated AAA and equivalent, and has exposure to lower credit ratings of AA and such in companies with good parentage or names that you recognize as good quality companies should give you comfort. The exposure to unrated papers and lower credit quality should form a very small percentage, say, not exceeding 5%, of the portfolio.
Also, make sure the portfolio does not have concentrated holding. For example, a portfolio that holds a considerable portion in securities issued by banks, financial institutions, NBFCs and HFCs is very vulnerable to a downturn in this segment.
The debt portion is the safe part of an investor’s overall portfolio, so focus on the risk and not the returns. Ask and find answers to how a fund is generating higher returns than its peers and the market, and assess whether you are comfortable with the strategy. Look at your exposure. Unless it is investment in a fund with no credit risk, because of sovereign or quasi-sovereign guarantee in the securities, it is important for a retail investor not to have too large an exposure, say more than 10% of debt allocation, to a single fund.
For most investors, debt funds are a tax-efficient alternative to traditional fixed-income products to provide liquidity and to park funds for different time horizons. Don’t deprive yourself of that advantage by exiting without cause. But at the same time, take only those risks which you understand.
With businesses grinding to a halt amid the lockdown, their ability to service debt obligations has become questionable. As a result, many debt fund investors rushed to redeem their investments—debt funds saw one of the highest-ever outflow of ₹1.94 trillion in March. For debt funds, this became difficult to handle as poor liquidity in the debt markets limited their ability to sell the securities. Though the Reserve Bank of India (RBI)took steps, including opening rupee-dollar swap windows and conducting long-term repo operations (LTRO), to improve liquidity in the bond markets, these were too little, too late for Franklin Templeton. So what does this mean for investors in these Franklin Templeton schemes and will it impact investors in other debt funds as well? We try to give the answers.
Investors in the affected schemes
If you have invested in any of the six affected schemes of Franklin Templeton, there’s literally no way out. No investments or redemptions are allowed in these schemes as of now. So you will not be able to redeem, switch out or transfer money from these schemes or start a systematic investment plan (SIP) or invest lump sums in these schemes.
Also, you will receive the proceeds the fund house is able to recover by liquidating the underlying investments in proportion to your holdings. From the investor’s perspective, the fund house will give back whatever money it realizes over a period of time.
How much money you’ll get back will depend on your investment amount as well as the amount the fund house is able to recover. It is uncertain when you will get the money as it will depend on how fast the fund house is able to recover it.
Investors in other debt schemes
The event will also impact schemes of Franklin Templeton Mutual Fund that invested in any of the six schemes, as they will not be able to exit these holdings. For instance, Franklin Templeton India Asset Allocation fund was holding around 46% of its assets in the Short-term Income Fund, as per the March-end portfolio. It will also severely impact the sentiments of investors in other debt schemes of Franklin Templeton, as well as those of other fund houses.
If you are invested in other debt schemes, don’t make this event a turning point for you. Instead, try to assess your fund by doing a portfolio review, asking the right questions and checking your exposure.
A portfolio that predominantly holds securities that are rated AAA and equivalent, and has exposure to lower credit ratings of AA and such in companies with good parentage or names that you recognize as good quality companies should give you comfort. The exposure to unrated papers and lower credit quality should form a very small percentage, say, not exceeding 5%, of the portfolio.
Also, make sure the portfolio does not have concentrated holding. For example, a portfolio that holds a considerable portion in securities issued by banks, financial institutions, NBFCs and HFCs is very vulnerable to a downturn in this segment.
The debt portion is the safe part of an investor’s overall portfolio, so focus on the risk and not the returns. Ask and find answers to how a fund is generating higher returns than its peers and the market, and assess whether you are comfortable with the strategy. Look at your exposure. Unless it is investment in a fund with no credit risk, because of sovereign or quasi-sovereign guarantee in the securities, it is important for a retail investor not to have too large an exposure, say more than 10% of debt allocation, to a single fund.
For most investors, debt funds are a tax-efficient alternative to traditional fixed-income products to provide liquidity and to park funds for different time horizons. Don’t deprive yourself of that advantage by exiting without cause. But at the same time, take only those risks which you understand.